HMRC's Goldman Sachs error: a timing issue?

THE BIG QUESTION in the tax community at the moment surrounds the error made by HM Revenue & Customs in its deal with investment bank Goldman Sachs, which lost the Exchequer up to £10m.

Speculation is mounting in the tax community over what the error was, with tax officials refusing to say, claiming confidentiality. HMRC permanent secretary Dave Hartnett repeatedly refers to an "impediment" that prevented HMRC from claiming the full amount, but will say no more.

An examination of court papers offers some clues. It could stem from HMRC's failure to take a key tribunal ruling into account when agreeing the deal with Goldman.

The 2009 ruling removed a time limitation obstacle that would otherwise have prevented HMRC from pursuing the bill.

Goldman Sachs had claimed that HMRC was pursuing the wrong business within its group for tax. Because of this, the bank said, HMRC was out of time to pursue the correct business – a different Goldman Sachs subsidiary based in the British Virgin Islands. But the tribunal ruled that HMRC had been pursuing the right business all along, removing any possible obstacle to collecting the full revenue, plus any interest.

With this in mind, did HMRC mistakenly believe there was still a time limitation in place blocking its pursuit of the full bill? If so, by failing to take the ruling into account there is every possibility it would be more inclined to enter into a settlement.

So what are the details behind this speculation?

The deal itself

The deal centres around an employee benefit trust run by Goldman Sachs. Between 2002 and 2005, HMRC was successful in closing down numerous schemes, which allowed employees to receive non-repayable loans that did not incur National Insurance contributions. HMRC managed to extract the full amount owed from 21 businesses: Goldman Sachs was the only one to hold out.

HMRC said the refusal to pay at that time would mean the bank would have to pay interest on the bill when it did finally pay. However, the deal struck in 2010 failed to charge Goldman Sachs interest.

The amount of money lost by the Exchequer is unclear. Private Eye and the Guardian, which broke the story, have mentioned the sum of £10m being lost.

But HMRC begun proceedings in the London County Court in 2003 to collect £30.8m and a leaked memo of a meeting involving HMRC general counsel Anthony Inglese suggested the figure settled at in 2010 was £24m.

Perhaps the most reliable figure was that identified by the National Audit Office, which said that around £5m-£8m was lost by the Exchequer when the settlement was made.

The 2009 rulings

HMRC has admitted that this lost revenue was due to an error. However, despite vigorous questioning from the Public Accounts Committee, HMRC cited taxpayer confidentiality and legal privilege, so the nature of the error remains undisclosed.

Of course, speculation is rife, but two related cases in 2009 provide some clues as to the nature of the error. The first was heard in October 2009, where Justice Norris ruled that a preliminary hearing was required to explore the issue of who was liable to pay the National Insurance contributions; the second case was the preliminary hearing, ordered by Norris, which took place in December 2009 and was heard by Judge David Williams.

Mistaken identification

Norris found that HMRC had been pursuing Goldman Sachs International (GSI) for the outstanding NI liabilities from 2002. The taxman commenced County Court proceedings against GSI in 2003, but this was never heard. This was not a major problem for HMRC – the relevant legislation states that, because it had started proceedings, it would not be bound by time limitations later on.

However, the Goldman Sachs group claimed that a company based in the British Virgin Islands, Goldman Sachs Services Limited (GSSL), was the employer of the individuals whose bonus payments were under scrutiny. GSSL contracts employees to work in Goldman Sachs offices around the world.

HMRC refuted the claim that GSSL was liable for the NI contributions due. As HMRC had made no claims against GSSL, any claims made subsequently would be out of time due to limitation legislation. HMRC's own Debt Management and Banking manual says that National Insurance debt over six years old should not be pursued, unless proceedings are already under way. Furthermore, GSSL has no funds left, which makes recoverability of the funds an issue.

In this case, Goldman Sachs as a group would only be liable for around £10m – due on the contributions of the few employees who officially transferred from GSSL to GSI in 2000. As HMRC had already begun proceedings against GSI, limitations would not apply on these employees from the date of their transfer. The bank said it would settle on £10m in these circumstances.

Time limitations

The taxman had a two-pronged argument against this: first, that GSI was liable for the bill and not GSSL; second, even if GSSL was liable, time limitations would not apply.

The central part of this second argument was that it was a case of mistaken identity – citing Section 35 of the Limitation Act 1980, which provides a mechanism for HMRC to substitute parties when pursuing tax.

However, this argument was problematic, Norris warned. He said that in previous cases, mistaken identification arguments were weak. In other words, it is not a route that HMRC should take.

Was GSSL resident?

But this should not have mattered. In December 2009, Judge David Williams ruled in favour of HMRC's first argument that GSSL was not liable for the bill and that GSI was.

Williams said that GSSL had no presence in the UK. The liable company would be GSI, as the host resident company of the employees.

Was this the error?

HMRC has admitted it wrongly thought there was an "impediment" to claiming the full amount. This is very different to getting its calculations wrong, which would be an obvious alternative explanation.

The deal was agreed at a meeting on 19 November 2010. If the officials at the meeting failed to take the Williams ruling into account, it is possible that they still thought the time limitation was the obstacle.

And without the ruling, it would have been a block. As Norris warned, HMRC's argument that limitations should not apply because it was a case of mistaken identification were weak.

In this case, the reported £24m would look good for both sides – more than the £10m Goldman Sachs would pay if HMRC lost on their weak argument, but lower than the £30.8m, plus seven years interest, that the bank would pay if HMRC won.

The governance error

There is another twist to this tale. Hartnett and Inglese told the PAC meeting this week that another error occurred – one concerning the governance structures surrounding the deal. Again, they would not say what this was.

But if we are right in our analysis of the error, this would mean that HMRC did commit a governance error when agreeing the deal. Presuming this was the case, then HMRC would have believed there were two possible outcomes if it were to litigate: if it could prove that limitations did not apply, then it would collect around £30.8m plus seven years interest; if the judge ruled that limitations did apply, it would only collect around £10m.

This is what HMRC's litigation and settlement strategy calls an "all-or-nothing" case – the "all" was the £30.8m plus interest, the nothing was the £10m for which GSI admitted liability. But as this was an all-or-nothing case, HMRC is not allowed to settle, according to its strategy. Hence, the governance error.

Speculate to accumulate

HMRC has said it cannot comment for legal reasons.

If our analysis is correct, the real questions to be answered are why did HMRC made such an error – what problems did it have with communication, why weren't lawyers involved throughout and could the nature of this error could be replicated elsewhere. Even if this was not the actual error, these questions will still apply.

Worse, if we are right and HMRC's legal position was not fully understood, could this be happening elsewhere in other cases costing the Exchequer further millions?

It is important to stress this is just speculation, but this explanation has not been ruled out. And, with HMRC stonewalling all other inquiries, speculation is all we have.